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Creating Inflation Is Hard in a Derivative-Laced World


The invention of financial futures has helped curtail inflation in the developed countries.

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The number one topic since Thursday's (July 3) Employment Report has been inflation. Depending on whom you listen to, the US is either about to or already experiencing an inflationary cycle. The idea of inflation -- rather than the actuality -- is easily attached to in "Sounds Right Macro," as virtually everyone can point to something that is now priced higher than before as evidence. The truth is creating inflation is much harder than most think.

In the developed market space, disinflation (and even flashes of deflation) have been far more common over the last 30 years. Asset price inflation has filled the void and created a safe harbor for the Neo-inflationists. The recent drop in the unemployment rate has sparked a flurry of inflation sightings.

Although I believe this cycle will be scored nominally, I am not convinced that a general inflation cycle has emerged. Central Bank(er) focus and QE have promulgated the impending inflation story. Remember the dollar-crashing hype of 2010? The reality is the widespread development of derivative contracts act as a huge impediment to a central bank that wants more inflation. Consider the economic blowback to the Fed taper last Spring. Futures markets were able to fast-forward to multiple tightenings at the first hint of Federal Reserve adjustment.

Former Federal Reserve Chairman Paul Volcker showed incredible resolve in cracking the 1970s inflation spiral. His success is highly correlated -- but rarely linked to -- the invention and use of financial futures. The ability to create inflation in the developed world since the widespread use of these products has been spotty, at best.

Even after last week's solid report, Treasury futures have rebounded into the growing inflation meme. The energy complex retreated sharply. If and when inflation gains some traction in the US, I fully expect the Bond Vigilantes to ride into town "a whoopin' and a hollerin' ," as Slim Pickens used to say, and scare the daylights out of the citizens of Rock Ridge.
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